IMF Approves Stand-By Credit for Bulgaria

The International Monetary Fund (IMF) today approved a 20-month stand-by credit for Bulgaria equivalent to SDR 400 million (about US$582 million) in support of the Government's 1996-97 economic and financial program. In view of the substantial policy actions already implemented by the Bulgarian authorities and the country's immediate need to replenish reserves, the IMF will disburse 40 percent of the total amount within the next two months.

Background

Bulgaria achieved remarkable macroeconomic stabilization results in 1995 as inflation fell sharply, real GDP growth edged up, and the external current account moved into a substantial surplus. But delays in addressing financial indiscipline in the enterprise and banking sectors undermined these results and contributed to the destabilization of the economy. Overconfidence led to easing of financial policies in the second half of 1995 and structural reforms stalled. Illiquid banks facing localized runs--often reflecting underlying insolvency--increasingly turned to the central bank for refinancing that became a major source of excess liquidity. Failure to prevent this liquidity from spilling into the foreign exchange market, while attempting to maintain a stable exchange rate through heavy official intervention, led to a severe fall in official reserves. This raised concerns about the banks' and the country's ability to meet their foreign currency liabilities, triggering the current banking and exchange crisis, marked by a sharp decline in the value of the lev.

The 1996-97 Program

Bulgaria's economic program, supported by the stand-by credit, aims at restoring macroeconomic stability, fending off the present financial crisis, and moving forcefully with long-delayed structural reforms. The authorities have resolved to tackle the underlying problems and have begun to implement a radical reform and stabilization program, that aims at stabilizing the economy, reducing the role of the public sector, and setting the stage for sustained economic growth.

The main macroeconomic objectives of the program are to: (a) achieve real GDP growth of 2.5 percent in 1997, after an expected stagnation in 1996; (b) sharply reduce inflation from 20 percent per month to 2 1/2 percent per month by end-1996, and to 1 1/2 percent per month by end-1997; (c) achieve an external current account surplus of 3.1 percent of GDP in 1996 and 2 percent of GDP in 1997; and (d) increase official international reserves by 50 percent by the end of 1996 to a level that will cover over 2 1/2 months of imports of goods and non-factor services, and to 3 1/2 months in 1997.

To achieve these goals, the program is centered on a substantial up-front fiscal adjustment, supported by a tight monetary policy, and an incomes policy designed to dampen inflationary pressures. The authorities have adopted measures to raise at least the equivalent of 2 percent of GDP in additional revenues in the second half of 1996, and to increase revenues further by 1 percentage point of GDP in 1997. The measures include an increase in the value-added tax from 18 percent to 22 percent, an improvement in tax administration, a substantial increase in excise taxes on alcohol and tobacco, and a temporary 5 percent import surcharge on goods for final consumption. On the expenditure side, the authorities intend to keep noninterest expenditures, other than wages and social expenditures, as close as possible to the nominal allocations approved in the budget in order to achieve the equivalent of a 2 percent of GDP cut in the level of spending compared with 1995. The fiscal adjustment will be concentrated during the second half of 1996 when domestic bank borrowing needs of the budget are to be substantially reduced. Building on this adjustment, the fiscal deficit is targeted to decline from 4.7 percent of GDP in 1996 to 2.6 percent in 1997. The authorities stand ready to take additional measures, if needed, to safeguard the objectives of the program.

The exchange rate will be market-determined and intervention will be limited to what is needed to rebuild official reserves and to smooth short-term fluctuations. Together with the reduction in the fiscal deficit, tight monetary policy should help to achieve an early stabilization of financial and exchange markets and a correction of the recent overshooting of the exchange rate.

Monetary policy will be supported by a restrictive incomes policy. Wages in the budgetary sphere are capped by a nominal limit on the wage bill, while wages in state-owned enterprises are to be adjusted for only 70 percent of the excess of inflation above 20 percent during 1996, unless productivity developments permit a larger increase. This policy should help to preserve external competitiveness and strengthen the external position.

Structural Reforms

Comprehensive structural reforms--to be supported by financial assistance from the World Bank--are the cornerstone of the authorities' strategy to prevent a recurrence of macroeconomic instability, reduce the role of the state, and lay the lasting foundations for a market economy and sustainable economic growth. While significant structural reforms were introduced in the early 1990s, the effort has stalled in recent years. As a result, banks continued to be ill supervised, the majority of industrial enterprises remained in the hands of the state, and utilities continued to provide subsidized inputs and services. Enterprise losses--in the past leading to quasi-fiscal deficits on the order of 4-5 percent of GDP--are expected to be cut by two thirds through liquidation and isolation of large loss-making enterprises and by privatization. Large administered price adjustments, led by a more than doubling of fuel and electricity prices over the past few weeks, have ended excessive subsidization and brought revenues in line with operating costs and the need to finance investments. Banks have been prohibited from lending to enterprises on the isolation list and to all borrowers with overdue payments for more than three months. A bank liquidation law has been adopted, giving the Bulgarian National Bank much needed powers to effectively supervise banks. The final impetus to a lasting resolution of problems of financial indiscipline in enterprises and banks will come from privatization. Cash privatization will be accelerated while the mass privatization program will be enhanced so that at least 25 percent of state-owned assets will have been transferred to private ownership by end-1996 and at least an additional 25 percent next year.

Social Issues

The costs related to the retrenchment of workers of liquidated and isolated enterprises will be financed with assistance from the World Bank. As part of a medium-term strategy toward improving the system of social insurance and assistance and reducing its burden on the budget, the Government will establish measures to better target benefits to the most needy. Such a scheme has already been adopted in the context of the recent administered price increases.

The Challenge Ahead

The Bulgarian authorities have embarked on a strong adjustment and reform program to help deal with the current crisis in financial markets. The stabilization package provides an appropriate response to the current circumstances. Its success will depend importantly on perseverance in implementing the structural reform program. The program is subject to a number of risks, but these risks have been lessened by the significant number of bold policy actions already implemented and the willingness of the authorities to strengthen policies as needed. The support of the international community is crucial to the success of the program.

Bulgaria joined the IMF on September 25, 1990. Its quota1 is SDR 464.90 million (about US$676 million), and its outstanding use of IMF credit currently totals SDR 385 million (about US$559 million).